To RRSP or not to RRSP?

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Should I put money into my RRSP or not?  Would my money be better off somewhere else, or is an RRSP my best option?  These are questions many Canadians ask themselves as the RRSP season rolls around each year. 

The answer to your question is ideally best addressed in a meeting with your financial advisor considering your personal variables, however there is a rule of thumb you can use to help you decide if an RRSP is something you should consider contributing to.

An RRSP offers two key features; the first is tax deferral and the second is tax savings.

When you put money into an RRSP you are basically saying to the government “Please forgive my tax owing on this income (your contribution) in this tax year (your write off) and in exchange I will pay my tax owing on this income plus growth in a future income tax year when I withdraw it.”  This is tax deferral.  You are deferring paying taxes on this money to a future year.

The other benefit you want to harness with an RRSP is the element of tax savings.  When you defer paying the tax until a year in the future, your goal should be to withdraw the money and pay the taxes when you are in a lower tax bracket than you are when you put it in.  This is essentially the tax savings part of it.

Determining if an RRSP is right for you is largely mathematical.  In order for an RRSP to work at its optimum, you need to put money IN when you are in a HIGHER income tax bracket, and take it OUT when you are in a LOWER income tax bracket.  You will see if you do it the other way around it can work against you.

Let’s look at two examples I’ve used in the past to illustrate the concept of tax savings and how planning can create an RRSP that works well for you and how improper planning can result in your RRSP working against you.

RRSP that works well:

Put $5,000 savings IN at 46% tax bracket ($2,300 tax savings in that year) and withdraw $5,000 down the road when you are in a 30% tax bracket (pay $1,500 in tax) = tax savings of $800.

RRSP that doesn’t work well:

Put $5,000 savings IN at 30% tax bracket ($1,500 tax savings in that year) and withdraw $5,000 down the road when you are in a 46% tax bracket (pay $2,300 in tax) = paying $800 more tax.

Please note in these examples, the issue is not the RRSP itself, but rather how the RRSP is used.  An RRSP can be the perfect solution for many people if used effectively.

If you are currently in a low income tax bracket, you believe you may be in a higher income tax bracket in the future, or expect your future income to rise significantly, an RRSP contribution this year may not be your best strategy.  A TFSA is a good option if you have room.

If you are currently in a high income tax bracket, you are in need of the tax write off, and you are most likely to be in a lower tax bracket at retirement when the money is withdrawn, an RRSP is probably a great choice for you.  You are most likely a textbook case for using an RRSP effectively.

If you are currently in a unique situation, ie: you are on maternity leave or sabbatical, a business owner or planning to start a business, or may need to get at your money in the near future you will want to do some careful planning.  Each of these scenarios require a bit more thought and consideration. 

As with most financial planners, my advice is different for each person depending on their personal situation.  There is never a one size fits all.  When deciding about your RRSP contribution, be sure to look at your personal situation, your tax bracket and get advice.

 

*This column appeared in This Month In Elgin February 2018 edition

 

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Stephanie Farrow, B.A., CFP.  Stephanie has 25 years experience in the financial services industry, a diploma in Financial Planning from the Canadian Institute of Financial Planning and Certified Financial Planner designation.  Stephanie has been writing financial planning columns for local business magazine Elgin This Month since 2010.  Stephanie and her husband Ken Farrow own Farrow Financial Services Inc.  About our Farrow Financial Team.

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